A Gruesome Chapter Closes at Duke

State regulators just forced Duke Energy (DUK) to remove their CEO and two other senior executives. Regulators also forced Duke Energy's board of directors to restructure, pay fines and keep 1,000 employees in Raleigh, N.C. But, even though this has all meant the heavy hand of government reaching deep into a private company's operations, it now seems there is some good news in all this: Control of the new Duke Energy will be returned to shareholders, including former Progress Energy shareholders.

With these decisions agreed upon, Duke Energy is now free to become the company shareholders had expected when they approved the Duke-Progress merger about a year ago. The combined company will have a new CEO and a new management team that regulators, employees and shareholders can trust. With major obstacles removed, Duke is now in a position to grow and prosper.

Those obstacles had suddenly appeared early last July. Just hours after the Duke-Progress merger was completed, the new CEO of the combined company had been suddenly fired by a split board of directors. The firing was unexpected, coming as a complete surprise to employees, shareholders and regulators.

The firing appears to be part of a power play by former Duke board members, who outnumbered and outvoted those from the former Progress board. It appears that these former Duke members, who had been on the job only a few hours, have railroaded the new CEO out of Duke -- and they've reinstated their old chief executive, James Rogers, to be the next CEO of the combined companies.

This move entailed incredible boardroom drama. It exposed serious conflicts among board members -- and, worse, their actions have damaged Duke's reputation with state regulators.

State regulators are the lifeblood of a regulated utility. The state, not the utility, decides what consumers will pay for their electricity. The state, not the utility, controls most of the company's revenue and margins. In the end, the state is in control of shareholders' returns. A utility's reputation is essential. If regulators lose trust in a utility, regulators become motivated to protect consumers by over-regulating and withholding rate relief (revenue) from the utility.

Earlier this year, I warned that Duke's regulators may overreach -- and they just did.

According to the Charlotte Business Journal, North Carolina regulators believe Duke Energy may have intentionally misled the state. While Duke admits no wrongdoing, the company does acknowledge that "its activities have fallen short of the commission's understanding of Duke's obligations under its regulatory compact that frame the duties for a regulated utility in this state."

In another Real Moneypiece this past July, I called for James Rogers to step down. I argued the company had lost its credibility and that it needed new leadership to restore shareholder, regulatory and public trust. It took a few months and growing pressure from state regulators, but Duke's board acted.

In order to get their regulators off their back and move past this issue, Duke will have to do more than terminate James Rogers' employment. According to the Charlotte Business Journal, state regulators are dictating choices in executives, board structure and new commitments to consumers.

The state is insisting that Duke change out two other senior executives. Specifically, it is requiring the replacement of Duke's general counsel and of its senior executive responsible for the company's regulated subsidiaries.

The state is also forcing Duke to restructure its board of directors. Regulators are insisting that Duke appoint two new board members, neither one of which may have any connection to the old Duke and Progress boards.

Another state requirement calls for Duke's board to set up a nine-person committee to nominate James Rogers' successor. Four must be from the old Duke board, another four are to be from the old Progress board and one will be a new member, to be chosen by April.

The state is added three additional requirements, as well. Duke must keep at least 1,000 employees in Raleigh, N.C., and provide millions in new cost cuts for North Carolina consumers. It's also required to pay millions more to the state for workforce development.

Thus ends a gruesome chapter in Duke's history. With a new management team arriving, the company can begin to repair its credibility with state regulators and other stakeholders. Duke has now become a safer investment.

But this is a warning for investors. Regulated utilities don't run themselves, and they are not country clubs. If your utility is like Duke, Pepco (POM) and Consolidated Edison (ED), which depend heavily on state commissions for approval of most of their revenue and margins, management must be diligent to maintain the trust of their regulators and the confidence of the public at large.